The US credit downgrade and its impact on speculative markets.

The downgrade of US credit by Standard and Poor to AA+ from AAA really did not have as large an impact as feared but nonetheless served as a kind of wake-up call for the international financial system. The US’s debt market remains the world’s largest, safest and most liquid, presenting the best investment for foreign currency reserves from abroad as well as providing an excellent safe haven for US investors, who hold the majority of US sovereign debt while China holds less than 10%. Ten percent is not such a dramatic number, especially when the media and those involved in its game try to make it appear as if the Chinese state is going to foreclose on us at any moment. In reality, the PRC and the US are doing the economic equivalent of MAD, the US knowing it can halt and disrupt China’s impressive economic growth and the PRC knowing it can stop lending the US money but at its own peril. China is making a lot of money. There is, sadly, nowhere for this currency to go that is as safe, liquid and large as the US debt market. The Euro does not denominate TBills in the Euro since it lacks a centralized debt market (some suggest this is something that needs remedying, see my earlier article here. The current international system of finance uses what is called a system of ‘floating exchange rates’ in which the value of sovereign currency is determined by economic output among other things. A call for the return of the gold standard shows not only a lack of understanding of what the gold standard was but also how the current system works. Fears that our nation will be repossessed are ill-founded and somewhat moronic. When Nixon closed the Gold window in 1971 (The Nixon Shock) he terminated the US dollar’s convertibility into gold and unilaterally terminated the Bretton Woods system of exchange. The gold window on the dollar that was the lynchpin of the Bretton Woods system allowed for other countries to value their currency in relation to the US dollar which was in turn valued at a certain percentage of gold. When the economies of Western Europe emerged from their defeat following WWII, they bought dollars as reserve currency. When the value of the dollar would dip, they could convert their dollars into gold and vice versa. This became a problem because the United States was acting as the central bank of the developed world, reaping all the costs as the holder of debt and little of the benefit. When Nixon closed this window, he declared the dollar separate from gold and any reserves held in the dollar would reflect the current market value of the dollar alone, no longer exchangeable for safer gold. The Bretton Woods system had many benefits prior to this action that were made somewhat obsolete as the 60s and early 70s came. The Bretton Woods system wanted to provide cheap loans and investment, as well as an international structure for a system of payments, that would prevent the war-torn, recovering nations after WWII from resorting to communism. By the 1970s, despite the propaganda otherwise, it was quite evident that communism was not going to sweep Europe unless it did so by martial force. The utility of the Bretton Woods system from the US standpoint had been mainly lost and instead they had an expensive system of exchanges to maintain. Dropping this system ushered in the modern financial system we have today. Prior to the end of Bretton Woods, the Gold Dollar acted as an almost universal currency, much like the British Pound Sterling did during the height of the British Empire. Today, the dollar acts in much the same way it did then. Some would say the currency’s value today is almost imaginary, but that simplifies a very complex issue, one that can affect the daily lives of people across the globe. The government needs fiscal responsibility but not at the cost of national development. As outlined above, China almost of necessity needs the US debt market and the US needs money to spend. Austerity may have more of a vicious, negative circular impact in that decreases in government spending depress the national economy, stalling demand and imports from China, hindering the PRC’s economic growth goals, shrinking the pool of available credit from China and leading to negative economic growth for both countries. Rinse, wash, repeat. Anyone who tells you these problems can be solved with a slogan or a platitude is here to rob you.

3 Responses

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